If you are thinking of buying another house or property, you may want to consider a second mortgage as a down payment. Many Canadians use a second mortgage to get cash at affordable rates using their home equity. Home equity is the current market value of your house minus the remaining payments you still have with your first mortgage.
A second mortgage is a loan made in addition to your primary mortgage. From your home equity, your lender will draw a lump sum that you will have to repay in regular payments, at a fixed or variable interest rate. Homeowners typically get second mortgages to fund other projects and expenditures, such as a second home or education.
Using a Second Mortgage for Down Payment
Up until the early 2000s, almost anybody can secure a second mortgage.
Borrowers who applied for second mortgage for second home acquisition could get up to 100 percent of the market value. Nowadays, lenders are not as generous. Before approving an application, they want to see solid equity in the homes they appraise. This is why homeowners tend to have a more difficult time getting a second mortgage.
Generally, a borrower can get second mortgage quotes from different sources, including a local bank or credit union, a mortgage broker or an online lender.
Private lenders tend to have more flexible guidelines and conditions compared to a traditional bank. This is because they are not impeded by internal bank policies and regulations. Do not forget to carefully screen prospective lenders to avoid needless problems. Read more in-depth about second mortgage lenders in Canada, or if you are in the US, check out this article.
As with your first mortgage, you must repay your second mortgage over a specified term, at the fixed interest rate you agreed upon with your lender.
There are two types of second mortgages – lump sum and line of credit. Lump sum is the standard, one-time loan that borrowers usually repay using fixed monthly fees.
A credit line functions just like a credit card, where you can borrow and repay multiple amounts of money from your lender, but within a maximum limit.
How Much Can I Borrow?
The amount of money you can get from your second mortgage depends on how much equity you have accumulated in your property. As a rule, you will be able to secure only a portion of your home equity.
Most mortgages allow borrowers to access up to 80% of their home equity. For instance, a property valued at $500,000, with a first mortgage worth $325,000, may net you up to $75,000. Most lenders also offer low-interest rates if your property’s loan-to-value ratio is at or below 80%.
How Can I Qualify?
Compared to first mortgages, second mortgages are riskier.
Lenders are a lot stricter in approving them because the chances of losing money is bigger. This is because a primary mortgage has priority and gets paid off first. If you want to know how to get a second mortgage to buy another house, consider your equity. The more equity you have, the higher your chances are for approval. Lenders also want to know if the applicant has a dependable income source to make payments.
Your credit score can determine your interest rate for your second mortgage.
Where Can I Use It?
During your loan application, your lender will ask for your reasons why you are getting a second mortgage.
Aside from getting a second mortgage for a second home, most borrowers want to use their loan to do home remodeling and improvements, as well as secure a mode of transportation. Others use the funds for education, emergency medical situations, reliable investments, and debt consolidation.
Lenders consider these as valid reasons for securing a second mortgage.
What Fees Should I Pay?
Just like when you took out your first mortgage, you also have to pay certain fees for your second mortgage.
For instance, your lender will charge you a credit check or convenience fee for pulling out your credit report. You will also have to shell out money for the appraisal costs and origination fees, which include payments for application, underwriting, and processing.
If your home equity slips below 20%, you need to pay for mortgage insurance. These fees can be hefty, so it is best to do some calculations beforehand.
Advantages of a Second Mortgage
Using a second mortgage as a down payment has its advantages.
You can borrow a significant amount of money since the loan is secured by your home, which is usually worth thousands of dollars. You can use the equity for a number of different situations, like home remodeling and investments. Interest rates for second mortgages are also often lower than other types of debt, such as a personal loan or credit line.
If you have a good credit score, this will help you secure a lower interest rate from your lender. In some cases, a borrower can get a deduction due to certain tax benefits.
This usually happens when you use the loan to buy or improve the home you used as collateral. Many second mortgage products offer one-year terms and interest-only payments. With this, your monthly payments will be significantly lower.
Disadvantages of a Second Mortgage
There are some instances when a borrower can have second thoughts in using a second mortgage for a down payment.
One of the biggest concerns is the risk of foreclosure. Since you are using your home as collateral for the second time, your lender can take over the property if you stopped making payments, leaving you and your family homeless. Interest for second mortgages is also often slightly higher than your first mortgage.
Lenders ask for higher interests because of the risk.
By default, the original mortgage gets paid first and has priority on the collateral. Also, applying for a second mortgage can be costly. The money you pay for fees such as credit checks, origination and appraisal can add up to thousands of dollars.
Moreover, a second mortgage may prove to be a hindrance in the event that you want to refinance, modify your loan or sell your house quickly.